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How Will the Economy Respond to Falling Oil Prices?

How will the economy respond to falling oil prices?  As noted several times the $30 decline in crude has shifted about 1.5% of global GDP from oil producers to oil consumers.  Approximately 70% of the US economy is consumer driven thus it can be concluded that Friday’s retail sales data could surprise on the upside.

But if the economy is consumer driven and if activity accelerates because of the drop in oil prices should this not cause an increase in interest rates because of greater economic activity?  In other words is the oil price drop inflationary versus deflationary?


The recent activity in the 10-year Treasury bond might confirm this view.  The 10-year Treasury bottomed in yield on October 15 at a 2.13% yield.  Oil broke through the psychological important $80 mark the same day, falling about $25/barrel from its June 30th levels.

Generally speaking, the equity markets which are an indicator of potential economic activity also bottomed that day.

Today the 10-year is trading around a 2.38% yield and oil is around $78/barrel and stock prices have rose.

Could it be further suggested inflation expectations and the oil price appear to have decoupled and perhaps there are other factors affecting bond prices such as the US labor market?

If oil declined because  lack of demand, will this decline soon reverse itself because of greater economic growth that spurs greater oil demand in the world’s largest economy and consumer of oil?

Wow!  I have a headache just writing this much less reading it.

How does this all relate to the markets?  I will argue if the monetary policy time table is accelerated because of greater economic activity, stocks could fall between 3% and 5%.  I will also write when this inevitable change does occur, prices will decline a like amount.

However this decline is only short lived.  According to Capitol Economics, in the 21 months after the start of a tightening, the average S & P 500 return for the seven tightening cycles since 1971 is 11.4%.

Regarding the 10-year Treasury, I think the 10-year can yield somewhere around 4% in next 18 months.

What will happen today?


Last night the foreign markets were mixed.  London was down 0.34%, Paris down 1.01% and Frankfurt down 1.27%.  Japan was up 0.43% and Hang Seng up 0.55%.

The Dow should open moderately lower on profit taking for as written several times, the averages feel “heavy.”   The 10-year is up 7/32 to yield 2.33%.

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Ken Engelke

Chief Economic Strategist Managing Director

The views expressed herein are those of Kent Engelke and do not necessarily reflect those of Capitol Securities Management. Any opinions expressed are statements of judgment on this date and are subject to certain risks and uncertainties which could cause actual results to differ materially from those currently anticipated or projected. Any future dividends, interest, yields and event dates listed may be subject to change. An investor cannot invest in an index, and its returns are not indicative of the performance of any specific investment. Past performance is not indicative of future results. This material is being provided for informational purposes only. Any information should not be deemed a recommendation to buy, hold or sell any security. Certain information has been obtained from third-party sources we consider reliable, but we do not guarantee that such information is accurate or complete. This report is not a complete description of the securities, markets, or developments referred to in this material and does not include all available data necessary for making an investment decision. Prior to making an investment decision, please consult with your financial advisor about your individual situation. Investing involves risk and you may incur a profit or loss regardless of strategy selected. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. If you would like to unsubscribe from this e-mail distribution, please reply to this e-mail and indicate that you wish to unsubscribe in your response.